ECB sovereign bond buying comes closer and closer

ECB President Mario Draghi and the People’s Bank of China were important in setting markets in motion last week. Draghi’s latest statements bring our base case of sovereign bond buying another step closer. The rate cuts by the Chinese central bank probably won’t affect the dire state of China’s real estate sector, but could contribute to a weaker Chinese currency.

These days, not a single week goes by without central banks making the headlines in financial media. This time it were statements by the European and Chinese central banks that had an impact on financial markets.

Euro has depreciated substantially, yuan has some way to go

ECB remains in driving seat to stimulate growth

With Draghi getting even more explicit about his intention to ease policy further, our base case of sovereign QE by the ECB comes closer and closer. We have seen the first small steps towards more policy coordination with the European Union’s announcement of a fund aimed at stimulating investment, but this was not of the size that investors and some political leaders were hoping for. Although this may be a step in the right direction, the ECB remains in the driving seat as far as growth stimulus is concerned. We therefore hold on to our base case of the ECB starting outright sovereign bond buying in the first quarter of 2015.

Chinese central bank reduces interest rates

The other central bank making the headlines was the People’s Bank of China (PBOC), which surprised the markets by cutting interest rates. The moves came after targeted fiscal easing and liquidity injections had failed to stabilise economic growth. The recent slowdown has been broad-based and most pronounced in real estate, infrastructure investment and the export sector. Only the services sector has been holding up well this year, but pressure there is likely to be felt in the coming quarters as employment growth is starting to weaken due to the problems in the construction and export sectors.

The decision of the PBOC was probably also driven by the aggressive monetary policy of the Bank of Japan. The weak yen has caused currency depreciation throughout Asia and policy makers in several countries have eased monetary policy. China, perhaps, has started to catch up with its peers in the region. So far, the yuan is one of the few currencies in the world that has been stable relative to the US dollar. Given the weak growth and low margins in the Chinese export sector, this does not look sustainable.